Debenhams survived 200 years in spite of hardships
The passion for financial engineering, in which a company can be acquired, indebted, stripped of its assets, reshaped, remodelled and returned to the public in a manner that produces rewards only for the financial engineers, is for me a constant puzzle. It's capitalism of a sort, that leaves even some capitalists uneasy.
The limits of this style of financial engineering hit home when I was examining the possibilities of a punt on the shares in the department stores group, Debenhams. In its 200-year history Debenhams has changed its name many times, entered and exited the stock exchange often, been the plaything of equity investors and yet it survived. Today, it is still a high street feature in more than 26 countries around the world.
By the middle of the 20th century, Debenhams was the largest department store in the UK. But by then it had had at least four name changes. In 1985, the sign over the door was changed again when the group became part of the Burton Group. Thirteen years later Burton itself was broken up into two new entities: Debenhams and Arcadia. Debenhams concentrated on department stores, and Arcadia became the owner of Dorothy Perkins, Topshop and Burton Menswear. That big switch saw Debenhams returned to the stock exchange.
Five years later, the company was acquired for £600m (€739m) by a group of US private equity giants that made a packet on the deal. In as little as three years they returned three times their initial investment. This was achieved by loading the company with debt, paying themselves large dividends, cutting back on store investment and doing sale and lease-back deals on the well-positioned Debenhams properties. As this was happening, people close to the buyout rejected any suggestion that they 'stripped' the business. Three years after the takeover, the investors packed up and Debenhams was once again back on the stock market. The floatation was poorly handled and left a sour taste.
The Debenhams' stores in the UK, Ireland and Denmark are owned by the listed company which has a market cap of slightly less than £1bn (€1.2bn). It fills its shelves with clothing and other 'own brand' goods carrying the Red Herring, Classic and Mantaray labels. It also markets the Debenhams' name and brands for stores operating under licence in 26 countries from Armenia to Vietnam.
The retail sector in the UK is undergoing profound change as online selling begins to bite. Store footfall is dropping and store costs are growing faster than sales. The Debenhams answer is to have fewer big sales and provide click-and-collect facilities for online orders. The group also intends extending its own brand range. Meanwhile, the surge in new franchise stores will continue. It plans 150 franchise stores in the next five years but does not intend opening any more Debenhams-owned stores.
Last year Debenhams' sales were up 2.5pc to £2.3bn (€2.8bn), achieved against the backdrop of weak consumer sentiment, highly competitive conditions and unhelpful weather. The international business grew by 4pc, but group operating profit declined 4pc to £168m, due to problems in the UK and Ireland. However, its Danish operation, Magasin du Nord, put in a strong performance.
Last year, the dreaded phrase 'business is challenging' entered the Debenhams' vocabulary and following three profit warnings, investors headed for the hills. As a result, Debenhams share price, at 73p, is just above its yearly low of 70p, even after the company spent £40m on share buy-backs. The shares now trade at less than half the floatation price of seven years ago. A lesson for investors: be vigilant of private equity floatation.
Debenhams' shares also trade at a discount to its sector, and its price-to-earnings ratio of nine is modest. So for investors, the question should be is it compelling enough to compensate for the risk? Interestingly, in recent times Mike Ashley, the billionaire founder of Sports Direct, took a quick 4.5pc stake in Debenhams which he soon sold at a profit. Ashley also obtained a derivative contract to obtain a 7pc stake by 2015. Analysts can't be sure if Sports Direct wants to negotiate shop concessions or whether Debenhams once again may be back in play?
Nothing published in this section should be taken as a recommendation, either explicit or implicit, to buy or sell any of the shares mentioned